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The Trump Effect (2)

19 January 2017
Richard Kemmish

In my previous post I argued that for various reasons we could see a resurgence in US dollar covered bond issuance by non-US borrowers, particularly at the long end of the curve. In other countries – Australia springs to mind – opponents of covered bond legislation were won over by precisely this sort of issuance. The Australian dollar denominated deals by European issuers made many observers ask why Australian pension funds were funding European homes when Australia should have been an importer of funds.  Maybe something similar could happen in America? Clearly the fiscal plans of the new administration put the US into the ‘net importer of capital’ group for the foreseeable future.

But this will be a minor consideration compared to the key determinant of the success or failure of the covered bond concept in America – the fate of the government ‘sponsored’ mortgage lenders, Fannie and Freddie. Received wisdom so far has been that whilst covered bonds in theory have bi-partisan support, their alternative is mainly favoured by the Democrats and that covered bonds will never really work in America until the agencies role starts to decline.  Now that we have Republican control of both houses and the presidency is it time for progress?

Seemingly yes. The new Treasury Secretary Steve Mnuchin has said that the return of Fannie and Freddie to public ownership is a top ten priority of the new administration. But actually this was the stated policy of the previous administration also, it just never happened. It is also significantly less extreme than the opinions of several (Republican, natch) congressmen who have called for the agencies to be wound down altogether.
Opposition to the privatisation / wind down of the agencies invariably come from advocates of higher home ownership and more affordable mortgages. Often it seems to be predicated on the fact that there is no viable alternative which is an interesting comment in the only country where securitisation has actually recovered after the financial crisis. But looking at ‘private label’ securitisations in the US it is clear that the European covered bond model is a far closer substitute to the funding available from the existing agencies.

Could the passage of covered bond legislation address the concerns of the opponents of agency privatisation? That would be quite a conciliatory approach, perhaps at odds with the ‘tone’ of the new administration. But if the US Covered Bonds act were to be proposed again, opposition to it would presumably be weaker if the privatisation of the agencies were going ahead at the same time.

The other consideration is whether covered bonds achieve recognition under the Basle rules. The new administration’s rhetoric to date suggests that international banking rules are unlikely to be particularly persuasive in the domestic debate, but if they happen to align with a ‘top 10’ priority, who knows?

Many of us have been wishing a US covered bond market into existence for many years. Maybe this time?

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